The Rise of Reddit: How Social Media Affects Belief Formation and Price Discovery

Using submission level data from social media platform Reddit, we rely on the theoretical framework of Pedersen (2022) to examine how social media affects belief formation, price discovery and trading dynamics. Consistent with the predictions on network belief spillover, we find that opinions of hard-headed investors (fanatic or rational) significantly predict future opinions of naïve investors, especially when these investors have larger influence. For return predictions, social media tones positively and significantly predict future returns, and more so when their influences are higher. Finally, for trading dynamics, higher agent tones increase retail flow and deter shorting flow in networks with higher influence. More interestingly, in the cases when short-sellers choose to increase shorting positions against higher tones, short’s negative predictive power for returns become the strongest. These findings generally support Pedersen’s predictions.